The FOMC concluded its meeting and released its statement. Later in the afternoon, Fed chairman Bernanke held the first ever post-meeting press conference. Nothing stated by the FOMC or by Mr. Bernanke himself was surprising, at least not to me.
This was not necessarily the case to many market participants, the airwaves were filled with comments made by pundits predicting language leaving open the possibility of an early end to QE2. Others predicted that the Fed would announce that it would consider not reinvesting the proceeds of maturing assets. Others still were predicting that the Fed would drop “extended period” from its statement regarding the Fed Finds rate. Alas, none of these were to be,
The Fed decided to permit QE2 to run its course, announced that it plans to reinvest proceeds from maturing QE2 assets and that policy will remain accommodative for an extended period of time. The decision to leave the course of policy unchanged was unanimous. Even Philadelphia Fed president Plosser and Dallas Fed president Fischer, two outspoken inflation hawks and QE2 critics voted for staying the course.
In his statement read at the press conference, Fed chairman Bernanke stated his case for staying the course, expressed concern that the growth may be moderating and called inflation pressures transitory. What Mr. Bernanke my mean is that food and energy prices are self-limiting and, in the case of oil prices, at least partially driven by speculation. The Fed has traditionally resisted being held hostage by speculators.
Arguments that the Fed could help the economy by raising rates, strengthening the dollar and putting more money back into the hands of the consumer. Although this idea has its merits, it must be acknowledged that the recovery we have seen thus far is a balance sheet recovery due to cheap corporate financing and favorable exchange rates for export business. Raising the Fed funds rate before employment and housing recovers could send corporate profits and the equity markets plummeting, the results could include a new round layoffs and further depression in the housing sector (Mr. Bernanke’s description of housing was “depressed”).
So what does this mean for interest rates? It obviously means that short-term rates, such as Fed Funds and three-month LIBOR will remain low. It could mean that long-term rates remain somewhat low. However, long-term rates could rise modestly as Fed policy will remain accommodative and foster some inflationary pressures. The opposite could occur when the Fed begins to tighten as disinflationary policies could result a halt to rising long-term rates before they gain much traction, but that is probably a year away.
Many readers will respond that they do not agree with Fed policy and therefore will choose investment strategies which run counter to Fed policy. One bets against the Fed at one’s own risk, The Fed sets policy, not me and not you. My personal view is that the economy needs a cleansing from borrowing and we as a nation must learn to live with in its means, However, that is not only impractical at this time because it would likely result in a recession which could be crippling, but also is not consistent with the Fed’s dual mandates of price stability and job growth. My views of what should be done are irrelevant. We only need to understand what the Fed will do and why and invest accordingly.
Make no mistake; the Fed cannot fix the economy. Mr. Bernanke knows that as well as anyone. He is just trying to keep things chugging along until the boys and girls on Capitol Hill make the necessary tough choices to make the economy fundamentally sound. What those choices are is a discussion for another day.
FYI: May begins my final year at my place of employment.
Wednesday, April 27, 2011
Monday, April 18, 2011
It's Been a Long Time
It has been a while since I posted commentary. Let's discuss recent events.
Retail sales rose for the ninth consecutive month, albeit at a slower pace, as consumers continue to spend in the face of higher food and energy prices. The increase of retail sales indicates that prices might not havee risen high enough to snuff out consumer spending, but may have risen high enough to slow it down. This could be an example of the economic headwinds which he have discusses previously. The economic headwinds may not be stiff enough to stop the U.S. recovery, but could be enough to slow it down.
It should also be mentioned that a recent pick up in hiring is probably helping consumers to keep pace with higher food and energy costs, but consumers are also being helped by the one-year suspension of payroll taxes. Temporary tax cuts usually carry temporary benefits for consumption. The benefits tend to wane months before the temporary tax cuts end. It is not inconceivable that the benefits of the temporary tax cuts begin to provide diminishing returns with regard to consumer spending in the coming months.
Many economists were encouraged by the increased consumer spending across a broad spectrum of the economy. However, retailers such as Wal-Mart are concerned that higher commodities prices will continue to squeeze consumers. Yesterday Rosalind Brewer, the president of Wal-Mart’s “Wal-Mart East” division said the following during an investor presentation:
“We still see our customer financially strapped. We see the shopper’s wallet being stretched a lot more.”
Wal-Mart’s experiences are worth watching as many of its customers are of the lower-income and middle-income variety. Higher food and energy prices tend to act like a regressive tax on consumption. This means that lower-income consumers are usually impacted the hardest. It is encouraging see that consumer spending continues to increase, but the deceleration is concerning. As physics teaches us, deceleration is actually acceleration in the other direction.
Worries about higher food and energy prices squeezing consumers are beginning to appear among market participants. An article in today’s Wall Street Journal discusses the recent drop in commodities prices and how concerns about a squeezed consumer and slower economic growth could be behind the decline.
Yesterday’s decline in stocks, oil and basic goods has raised concerns that commodities prices have become too expensive for consumers who continue to deal with high unemployment and stagnant wages. Government data released yesterday reported a decline of U.S. exports in February, the first decline since August 2010. Many industry economists continue to lower growth estimates for 2011.
One market participant told Bloomberg News:
"The potential for a slowdown in the global growth story has finally come to fruition. I'm not saying we're going to get a recession, but if you look at the range of growth estimates for the year, people are coming in more toward the bottom of the range. It looks like expectations are on the muted side."
Many pundits and most consumers point to soaring gasoline prices as evidence of inflation. To anyone who must drive to work or to shuttle one’s family from place to place, higher fuel prices are inflationary. However, to the bond market and to many Fed officials inflation is not yet a problem.
We would caution investors against making fixed investment decisions based whether they or some pundit believes the Fed is wrong. It matters not what they believe the Fed should do about higher food and energy prices. It does not matter what we believe the Fed should do about higher food and energy prices. It only matters what the FOMC (specifically Ben Bernanke) believes the Fed should do about higher food and energy prices (or prices and growth as a whole for that matter). Bet against the Fed at your own risk.
Thus far the Fed has given us hints of what it may do going forward. It is probable that the Fed continues QE2 through June as planned, but then ceases bond purchases for the purpose of quantitative easing. That in itself could be considered policy tightening because it potentially removes price support (yield suppression) for the bond market. Higher yields in the open markets could curb inflation (and growth).
However, the cessation of QE2 may not have the effect on interest rates that most people expect. We would like to bring you back to last year when the Fed halted bond purchases as it let QE1 wind down. Following the cessation of QE1 (and other government stimulus measures), the yield of the 10-year treasury note fell.
Why did the yield of the 10-year U.S. treasury note fall when the Fed ended QE1 purchases and rise when the Fed announced it would purchase bonds to keep real interest rates at accommodative levels? The markets viewed the cessation of QE1 as disinflationary (the soft patch into which the U.S. economy fell was largely blamed on the removal of government stimulus). The markets viewed the possibility followed by the implementation of QE2 as being potentially inflationary.
When one stops to think, these were logical reactions. Why else would the Fed engage in quantitative easing except to stimulate consumption and economic growth which are usually inflationary in their effect? The drop in rates following the cessation of QE1 likely reflected market sentiment that a double-dip recession was possible. The response to QE2 was a kind of relief price selloff / yield rally. So what do fixed income market participants believe is coming down the pike? For that we turn to the Bloomberg survey
Retail sales rose for the ninth consecutive month, albeit at a slower pace, as consumers continue to spend in the face of higher food and energy prices. The increase of retail sales indicates that prices might not havee risen high enough to snuff out consumer spending, but may have risen high enough to slow it down. This could be an example of the economic headwinds which he have discusses previously. The economic headwinds may not be stiff enough to stop the U.S. recovery, but could be enough to slow it down.
It should also be mentioned that a recent pick up in hiring is probably helping consumers to keep pace with higher food and energy costs, but consumers are also being helped by the one-year suspension of payroll taxes. Temporary tax cuts usually carry temporary benefits for consumption. The benefits tend to wane months before the temporary tax cuts end. It is not inconceivable that the benefits of the temporary tax cuts begin to provide diminishing returns with regard to consumer spending in the coming months.
Many economists were encouraged by the increased consumer spending across a broad spectrum of the economy. However, retailers such as Wal-Mart are concerned that higher commodities prices will continue to squeeze consumers. Yesterday Rosalind Brewer, the president of Wal-Mart’s “Wal-Mart East” division said the following during an investor presentation:
“We still see our customer financially strapped. We see the shopper’s wallet being stretched a lot more.”
Wal-Mart’s experiences are worth watching as many of its customers are of the lower-income and middle-income variety. Higher food and energy prices tend to act like a regressive tax on consumption. This means that lower-income consumers are usually impacted the hardest. It is encouraging see that consumer spending continues to increase, but the deceleration is concerning. As physics teaches us, deceleration is actually acceleration in the other direction.
Worries about higher food and energy prices squeezing consumers are beginning to appear among market participants. An article in today’s Wall Street Journal discusses the recent drop in commodities prices and how concerns about a squeezed consumer and slower economic growth could be behind the decline.
Yesterday’s decline in stocks, oil and basic goods has raised concerns that commodities prices have become too expensive for consumers who continue to deal with high unemployment and stagnant wages. Government data released yesterday reported a decline of U.S. exports in February, the first decline since August 2010. Many industry economists continue to lower growth estimates for 2011.
One market participant told Bloomberg News:
"The potential for a slowdown in the global growth story has finally come to fruition. I'm not saying we're going to get a recession, but if you look at the range of growth estimates for the year, people are coming in more toward the bottom of the range. It looks like expectations are on the muted side."
Many pundits and most consumers point to soaring gasoline prices as evidence of inflation. To anyone who must drive to work or to shuttle one’s family from place to place, higher fuel prices are inflationary. However, to the bond market and to many Fed officials inflation is not yet a problem.
We would caution investors against making fixed investment decisions based whether they or some pundit believes the Fed is wrong. It matters not what they believe the Fed should do about higher food and energy prices. It does not matter what we believe the Fed should do about higher food and energy prices. It only matters what the FOMC (specifically Ben Bernanke) believes the Fed should do about higher food and energy prices (or prices and growth as a whole for that matter). Bet against the Fed at your own risk.
Thus far the Fed has given us hints of what it may do going forward. It is probable that the Fed continues QE2 through June as planned, but then ceases bond purchases for the purpose of quantitative easing. That in itself could be considered policy tightening because it potentially removes price support (yield suppression) for the bond market. Higher yields in the open markets could curb inflation (and growth).
However, the cessation of QE2 may not have the effect on interest rates that most people expect. We would like to bring you back to last year when the Fed halted bond purchases as it let QE1 wind down. Following the cessation of QE1 (and other government stimulus measures), the yield of the 10-year treasury note fell.
Why did the yield of the 10-year U.S. treasury note fall when the Fed ended QE1 purchases and rise when the Fed announced it would purchase bonds to keep real interest rates at accommodative levels? The markets viewed the cessation of QE1 as disinflationary (the soft patch into which the U.S. economy fell was largely blamed on the removal of government stimulus). The markets viewed the possibility followed by the implementation of QE2 as being potentially inflationary.
When one stops to think, these were logical reactions. Why else would the Fed engage in quantitative easing except to stimulate consumption and economic growth which are usually inflationary in their effect? The drop in rates following the cessation of QE1 likely reflected market sentiment that a double-dip recession was possible. The response to QE2 was a kind of relief price selloff / yield rally. So what do fixed income market participants believe is coming down the pike? For that we turn to the Bloomberg survey
Sunday, April 3, 2011
Truth About Jobs
Friday’s employment data were considered, by some estimates, to be the first true sign that employment is beginning to gain some traction. You may recall that the January data was believed to have been negatively impacted by inclement weather throughout much of the country. This was followed by a strong report in February, but much of the improvement was credited to a snap back in hiring (a make up effect) from the weather-influenced January data.
We believe that one economist summed it up well when he said:
“It’s not a blow-out number but all in all, it’s a good report.”
Most data components indicated improvements. Even government job cuts slowed from a prior -46,000 to -14,000. Professional and Business services (+78,000), Education and Health (45,000), Health and Social Assistance (45,000) and Leisure and Hospitality (37,000) led the sectors reporting gains. The Information sector came in at -4,000 and Transportation and Warehouse did not add any jobs. Manufacturing added 17,000 jobs. The forecast called for a gain of 30,000 new manufacturing jobs.
The so-called household survey reported a drop in the unemployment rate from 8.9% to 8.8%, even as the labor force increased by 160,000. However, the labor force participation rate remained unchanged at 64.2%. This is still below participation rate of 64.9% from years ago.
How can the labor force expand, but the participation rate increase? This is the result of an expanding U.S. population. It is generally agreed that the U.S. economy needs to add approximately 200,000 new jobs each month just to keep pace with the expanding population.
Not all of the numbers were good. Average Hourly Earnings were unchanged on a month-over-month basis and remained unchanged at a pace of +1.7% on a year-over-year basis. Therein lies the problem. Wages are not keeping pace with commodities prices. Consumers, especially middle-income and lower-income consumers, are being squeezed and must make difficult decisions between discretionary spending and heating their homes, fueling their car, putting enough food on the table or taking vacations, buying new appliances, or improving their homes.
Many businesses are also being squeezed. The Average Hourly Earnings data and the Average Weekly Hours data indicate that business spending on labor has not kept pace with corporate profits. Many businesses continue to find it difficult to pass along price increases to consumers as consumers may put off purchases rather than pay higher prices. To compensate for a lack of pricing power, companies continue to squeeze workers by trying to get more production from them and not offering much in the way of pay increases. Unless wage growth takes hold, higher commodities prices could be a drag on consumption. Even the Fed (and individual Fed officials) have lowered their growth forecasts.
Speaking of Fed officials, Minneapolis Fed president Narayana Kocherlakota stated in an interview that the Fed may need to raise short-term interest rates by year-end if underlying inflation rises. Inflation hawks and bond bears (who are usually equity bulls) ran with this story and began predicting an interest rate blow-out to anyone who would listen.
Mr. Kocherlakota believes that higher commodities prices may bleed into core inflation and require the Fed to raise rates. He uses the oft-cited Taylor Rule (which we have mentioned previously) to support his case for higher policy rates. Mr. Kocherlakota believes that inflationary pressures could result in a 75 basis point Fed Funds rate increase according to the Taylor Rule. He makes no mention of whether or not the 75 basis point increase would follow, precede or accompany a selling of U.S. treasury securities holdings accumulated between two rounds of quantitative easing.
According the Taylor Rule, an effectively negative Fed Funds rate was required to boost price pressures (and economic growth) prior to the Feds launch of two rounds of quantitative easing. A 75 basis point increase of the Fed Funs rate may only get the effective Fed Funds rate back to 0.00% or so if QE holdings remain on the Fed’s balance sheet.
We do not dispute that the Fed will change its bias to one of less accommodative Fed policies, but how it may begin to tighten remains unclear. The Fed could remove much stimulus by selling its U.S. treasury holdings without raising the Fed Funds rate. Simply not purchasing additional U.S. treasuries would result in effective tightening of monetary policy. Whether the Fed chooses to first raise rates or reduce the size of its balance sheet remains a question, but it is likely that the first move the Fed will make is to cease QE2 purchases in June.
Although they do not get the media attention given to the inflation hawks, there are a number of Fed officials who do not believe that QE2 purchases will be curtailed. Cleveland Fed president Sandra Pianalto said yesterday that “several important factors will keep inflation in check" and that among them, are "the continuing slow growth in wages, which helps determine the cost of producing goods and services and, in turn, the prices set by firms" and "retailers' reluctance to raise prices in the face of strong competition and soft business conditions."
This morning, New York Fed president William Dudley said in a speech in San Juan, Puerto Rico that he currently does not see a reason for reversing Fed policy in what remains a “still tenuous” recovery. He also termed the recovery as being “far from the mark” of the Fed’s goals of full employment and price stability. It is believed that Mr. Dudley’s view of the economy and Fed policy is similar to that of Fed Chairman Ben Bernanke. Also, the New York Fed president is usually the most influential of the presidents of the regional Fed banks.
Mr. Dudley went on to state:
“We must not be overly optimistic about the growth outlook. A stronger recovery with more rapid progress toward our dual mandate objectives is what we have been seeking. This is welcome and not a reason to reverse course.”
We would like to be clear that there is little contention on the street that the Fed will begin removing stimulus. However, how, when and to what degree the Fed removes stimulus is the subject of much disagreement. Based on recent comments from Fed chairman Bernanke and New York Fed president Dudley, the first step in removing Fed stimulus is likely to be the follow through on QE2 in June. Following that, it is likely the Fed will analyze economic data and gauge the markets’ reaction to both the economic data and the ending of QE2. If the recovery looks like it is gaining more traction and / or core inflation begins to spike, the Fed could raise the Fed Funds rate, begin reducing the size of its balance sheet or a combination of both.
Judging by the pace of the recovery, the population-replacement-like pace of job growth, a lack of wage growth and the lack of business pricing power that has been observed thus far, it is probably unlikely that we will see a spike in shot-term interest rates. Using Mr. Kocherlakota's favored Taylor rule as a guide and considering the unprecedented stimulus it has required just to get the economy to the current pace of recovery, it might turn out that not much tightening will be necessary to reign in inflation end keep growth under control. We doubt that many Fed officials are fearful of an overheating economy.
Following this morning’s economic data prices of long-dated treasuries are little changed. The price of the benchmark 10-year U.S. treasury note is up 3/32s to yield 3.46%. The price of the 30-year U.S. government bond is up 4/32s to yield 4.50%.
There is a possible phenomenon which some investors may have failed to consider, that being the possibility that the removal of Fed stimulus is considered by market participants to be anti-inflationary resulting moderating the rise of long-term interest rates. You might recall that following the launch of QE2 last November, long-term treasury yields began to rise due to fears that the latest round of Fed stimulus would prove to be inflationary. The reverse may be true when QE is halted and, eventually, removed.
When the Fed raises the Fed Funds rate, the response from fixed income market participants (at some point during the tightening cycle) is that the Fed has tightened more than enough to combat inflation and begins to move capital farther out on the yield curve. Since QE is akin to lowering the Fed Funds rate, the removal of QE2 could have the same effect as raising the Fed fund rate.
Bloomberg has posted a revised interest rate forecast as per their survey of fixed income market participants. The current year-end 2011 forecasts are as follows:
Interest Rate Forecasts Q4 2011 Q1 2012 Q2 2012
30-year: 4.95% 5.14% 5.23%
10-year: 3.89% 4.10% 4.21%
2-year: 1.33% 1.68% 1.95%
3-month USD LIBOR 0.62% 0.89% 1.27%
Fed Funds Target Rate .25% 0.50% 1.00%
As you can see, the street does not believe that interest rates are poised to take off, but rather rise gradually. If these forecasts come close to fruition, a laddered portfolio with a duration on the belly of the curve 5 to 7 years out (with maturities out top 10 years) may prove to be advantageous. Step-ups could provide some cushion against modestly higher long-term rates, but floaters adjusting off of short-term benchmarks, such as LIBOR, may disappoint investors.
The truth of the matter is that the recovery sucks. This is due to two factors.
1) The economy is not fundamentally capable of growth rates seen during recoveries of the past two decades. A perfect storm of evermore accommodative Fed policies and ever easier lending standards combined to fuel economic growth by promoting borrowing.
2) Consumers will have to continue to deleverage.
The economy will recover slowly and peak at what will be a disappointing level for many Americans spoiled by getting what they want when the want it.
We believe that one economist summed it up well when he said:
“It’s not a blow-out number but all in all, it’s a good report.”
Most data components indicated improvements. Even government job cuts slowed from a prior -46,000 to -14,000. Professional and Business services (+78,000), Education and Health (45,000), Health and Social Assistance (45,000) and Leisure and Hospitality (37,000) led the sectors reporting gains. The Information sector came in at -4,000 and Transportation and Warehouse did not add any jobs. Manufacturing added 17,000 jobs. The forecast called for a gain of 30,000 new manufacturing jobs.
The so-called household survey reported a drop in the unemployment rate from 8.9% to 8.8%, even as the labor force increased by 160,000. However, the labor force participation rate remained unchanged at 64.2%. This is still below participation rate of 64.9% from years ago.
How can the labor force expand, but the participation rate increase? This is the result of an expanding U.S. population. It is generally agreed that the U.S. economy needs to add approximately 200,000 new jobs each month just to keep pace with the expanding population.
Not all of the numbers were good. Average Hourly Earnings were unchanged on a month-over-month basis and remained unchanged at a pace of +1.7% on a year-over-year basis. Therein lies the problem. Wages are not keeping pace with commodities prices. Consumers, especially middle-income and lower-income consumers, are being squeezed and must make difficult decisions between discretionary spending and heating their homes, fueling their car, putting enough food on the table or taking vacations, buying new appliances, or improving their homes.
Many businesses are also being squeezed. The Average Hourly Earnings data and the Average Weekly Hours data indicate that business spending on labor has not kept pace with corporate profits. Many businesses continue to find it difficult to pass along price increases to consumers as consumers may put off purchases rather than pay higher prices. To compensate for a lack of pricing power, companies continue to squeeze workers by trying to get more production from them and not offering much in the way of pay increases. Unless wage growth takes hold, higher commodities prices could be a drag on consumption. Even the Fed (and individual Fed officials) have lowered their growth forecasts.
Speaking of Fed officials, Minneapolis Fed president Narayana Kocherlakota stated in an interview that the Fed may need to raise short-term interest rates by year-end if underlying inflation rises. Inflation hawks and bond bears (who are usually equity bulls) ran with this story and began predicting an interest rate blow-out to anyone who would listen.
Mr. Kocherlakota believes that higher commodities prices may bleed into core inflation and require the Fed to raise rates. He uses the oft-cited Taylor Rule (which we have mentioned previously) to support his case for higher policy rates. Mr. Kocherlakota believes that inflationary pressures could result in a 75 basis point Fed Funds rate increase according to the Taylor Rule. He makes no mention of whether or not the 75 basis point increase would follow, precede or accompany a selling of U.S. treasury securities holdings accumulated between two rounds of quantitative easing.
According the Taylor Rule, an effectively negative Fed Funds rate was required to boost price pressures (and economic growth) prior to the Feds launch of two rounds of quantitative easing. A 75 basis point increase of the Fed Funs rate may only get the effective Fed Funds rate back to 0.00% or so if QE holdings remain on the Fed’s balance sheet.
We do not dispute that the Fed will change its bias to one of less accommodative Fed policies, but how it may begin to tighten remains unclear. The Fed could remove much stimulus by selling its U.S. treasury holdings without raising the Fed Funds rate. Simply not purchasing additional U.S. treasuries would result in effective tightening of monetary policy. Whether the Fed chooses to first raise rates or reduce the size of its balance sheet remains a question, but it is likely that the first move the Fed will make is to cease QE2 purchases in June.
Although they do not get the media attention given to the inflation hawks, there are a number of Fed officials who do not believe that QE2 purchases will be curtailed. Cleveland Fed president Sandra Pianalto said yesterday that “several important factors will keep inflation in check" and that among them, are "the continuing slow growth in wages, which helps determine the cost of producing goods and services and, in turn, the prices set by firms" and "retailers' reluctance to raise prices in the face of strong competition and soft business conditions."
This morning, New York Fed president William Dudley said in a speech in San Juan, Puerto Rico that he currently does not see a reason for reversing Fed policy in what remains a “still tenuous” recovery. He also termed the recovery as being “far from the mark” of the Fed’s goals of full employment and price stability. It is believed that Mr. Dudley’s view of the economy and Fed policy is similar to that of Fed Chairman Ben Bernanke. Also, the New York Fed president is usually the most influential of the presidents of the regional Fed banks.
Mr. Dudley went on to state:
“We must not be overly optimistic about the growth outlook. A stronger recovery with more rapid progress toward our dual mandate objectives is what we have been seeking. This is welcome and not a reason to reverse course.”
We would like to be clear that there is little contention on the street that the Fed will begin removing stimulus. However, how, when and to what degree the Fed removes stimulus is the subject of much disagreement. Based on recent comments from Fed chairman Bernanke and New York Fed president Dudley, the first step in removing Fed stimulus is likely to be the follow through on QE2 in June. Following that, it is likely the Fed will analyze economic data and gauge the markets’ reaction to both the economic data and the ending of QE2. If the recovery looks like it is gaining more traction and / or core inflation begins to spike, the Fed could raise the Fed Funds rate, begin reducing the size of its balance sheet or a combination of both.
Judging by the pace of the recovery, the population-replacement-like pace of job growth, a lack of wage growth and the lack of business pricing power that has been observed thus far, it is probably unlikely that we will see a spike in shot-term interest rates. Using Mr. Kocherlakota's favored Taylor rule as a guide and considering the unprecedented stimulus it has required just to get the economy to the current pace of recovery, it might turn out that not much tightening will be necessary to reign in inflation end keep growth under control. We doubt that many Fed officials are fearful of an overheating economy.
Following this morning’s economic data prices of long-dated treasuries are little changed. The price of the benchmark 10-year U.S. treasury note is up 3/32s to yield 3.46%. The price of the 30-year U.S. government bond is up 4/32s to yield 4.50%.
There is a possible phenomenon which some investors may have failed to consider, that being the possibility that the removal of Fed stimulus is considered by market participants to be anti-inflationary resulting moderating the rise of long-term interest rates. You might recall that following the launch of QE2 last November, long-term treasury yields began to rise due to fears that the latest round of Fed stimulus would prove to be inflationary. The reverse may be true when QE is halted and, eventually, removed.
When the Fed raises the Fed Funds rate, the response from fixed income market participants (at some point during the tightening cycle) is that the Fed has tightened more than enough to combat inflation and begins to move capital farther out on the yield curve. Since QE is akin to lowering the Fed Funds rate, the removal of QE2 could have the same effect as raising the Fed fund rate.
Bloomberg has posted a revised interest rate forecast as per their survey of fixed income market participants. The current year-end 2011 forecasts are as follows:
Interest Rate Forecasts Q4 2011 Q1 2012 Q2 2012
30-year: 4.95% 5.14% 5.23%
10-year: 3.89% 4.10% 4.21%
2-year: 1.33% 1.68% 1.95%
3-month USD LIBOR 0.62% 0.89% 1.27%
Fed Funds Target Rate .25% 0.50% 1.00%
As you can see, the street does not believe that interest rates are poised to take off, but rather rise gradually. If these forecasts come close to fruition, a laddered portfolio with a duration on the belly of the curve 5 to 7 years out (with maturities out top 10 years) may prove to be advantageous. Step-ups could provide some cushion against modestly higher long-term rates, but floaters adjusting off of short-term benchmarks, such as LIBOR, may disappoint investors.
The truth of the matter is that the recovery sucks. This is due to two factors.
1) The economy is not fundamentally capable of growth rates seen during recoveries of the past two decades. A perfect storm of evermore accommodative Fed policies and ever easier lending standards combined to fuel economic growth by promoting borrowing.
2) Consumers will have to continue to deleverage.
The economy will recover slowly and peak at what will be a disappointing level for many Americans spoiled by getting what they want when the want it.
Subscribe to:
Posts (Atom)